Thursday, January 24, 2013

Christopher Begg's East Coast Asset Management is out with their Q4 letter. Last time, we highlighted their letter on investment process and this time around, they focus on examples of 'transformations' that they invest in.

East Coast defines transformations as businesses that often have average or below-average economics and they are focused on seeking the cause that will produce a 'meaningful inflection point of change' on the economics of the business.

Begg writes,

"Our investment process becomes considerably more important when we try to ascertain if a business is truly transforming and emerging toward greatness. Every business is either getting better or worse with change, and we feel the market tends to value businesses on a one-point perspective by inferring the status quo. This can lead to mispricings for those transformations that we identify prior to change agents being reflected on businesses' financial statements."

Ray Dalio, founder of Bridgewater Associates, spoke with CNBC at Davos about a myriad of topics. Dalio started Bridgewater with $5 million and now manages $130 billion. His Pure Alpha hedge fund ended 2012 up 0.8% though his long-term returns are much more impressive.

Cash Will Move Into 'Stuff'

The Bridgewater founder thinks 2013 will be a year of transition as
cash moves into 'stuff' like goods, services, financial assets
(equities, gold, etc).

He points out that there's so much cash in the system due to central bank action. Since cash has a negative real return, he argues that it has to go somewhere as risks are being reduced. The desire to hold cash is being reduced.

Dalio laid out his framework as essentially a scenario where US investors pile into stocks driving markets higher which will then give the Fed confidence to start to tighten, which will then cause a pullback across risk assets.

Bearish on Europe

However, he's quite bearish on Europe it seems noting that there's a terrible economy with a gradual restructuring. He says there will be a depression there or a 'lost decade'.

Wisdom From Dalio

Dalio also had a some fantastic quotes about approaching investing, saying that,

"The way to look at any market... is to look at the buyers and sellers and to understand who's buying and who's selling and what the motivations are behind that."

He went on to note that,

"Too many investors are reactive decision makers... if something has gone up, they say 'ah, that's a good investment,' they don't say 'that's more expensive.' It's the most common mistake in investing. You have to look ahead and say what is the transaction? What will determine the buyer or seller?"

Dalio also points out:

"So much of the driver of any asset class returns is based on how events actually transpire relative to expectations. So there's a certain discounted growth rate in equities."

Lastly, Dalio made an excellent analogy comparing investing to poker:

"The bets are zero sum. In order for you to beat me in the game, it's like poker, it's a zero sum game. We have 1,500 people that work at Bridgewater, we spend hundreds of millions of dollars on research, and so on. We've been doing this for 37 years and we don't know that we're going to win. We have to have diversified bets. So it's very important for most people to know when not to make a bet. Because if you're going to come to the poker table, you're going to have to beat me, and you're going to have to beat those who take money. So the nature of investing is that a very small percentage of the people take money essentially in that poker game away from other people who don't know when prices go up whether that means it's a good investment or if it's a more expensive investment."

This analogy is not a new concept and there are actually many similarities between poker and investing/trading. Numerous hedge fund managers play poker (like David Einhorn) and we've highlighted the link between hedge fund managers and poker.

Yelp (YELP): Joho bought more YELP per a 13G filed with the SEC and now own 974,795 shares as of December 31st. This marks around a 9% increase in their position size since the middle of December, when they originally initiated their YELP stake.

Per Google Finance, Yelp is "operates a directory services and social networking website. Its online community provides information on urban city guide. The Company is based in the United States and its information helps people to find places to eat, shop, drink, relax, and play."

21Vianet Group (VNET): Per an amended 13G filed with the SEC, Karr's firm now owns 1,799.206 shares of VNET. The filing was made due to portfolio activity on December 31st and marks only a slight decrease in their overall position size (around -16%).

Per Google Finance, 21Vianet Group "operates as an Internet Service Provider (ISP). The Company operates as an ISP service supplier in China. Its main business includes Internet Data Center (IDC) service, Content Delivery Network (CDN), Enterprise Data Center (EDC) service and Data Center based industry solutions."

Kynikos Associates' founder Jim Chanos recently sat down with Reuters to talk about why he's shorting the personal computer industry, China's debt load, and other topics. He started by talking about what he's looking for as a short seller:

Chanos points to reading SEC filings as a must, saying that "it's
amazing how many investors don't do that... it's a must. Those
documents exist for a reason." He looks for an exodus from a company, a
large amount of stock sales, companies impacted by technological change
(citing the internet as a perfect example).

Why Chanos Is Short PC's

Hewlett Packard (HPQ) is one of his largest shorts and Chanos says that the company has a lot of 'baggage' due to mistakes made by previous management (acquisitions etc). He also points to the company's lack of investing in research & development as they've missed mobile and just cutting costs to create value isn't enough.

"while we look at financials in the rear view mirror, you can't forget to look out the windshield."

On Herbalife (HLF)

Chanos hasn't publicly commented on Herbalife (HLF) but notes he's studied multi-level marketing and that the important thing to focus on is, "How much of a product is sold through? Is the customer actually using the product?"

Kynikos has been short since 2009 and they haven't changed their thinking. Chanos says the thing to worry about is how China keeps adding more debt to keep the growth going.

He's short Chinese banking companies, property developers, cement companies and the like. He notes that the other way to play it is via shorting materials like iron ore companies. We've posted David Einhorn's short thesis on iron ore as well.

Chanos' Equities Outlook

He says that he's "a little less sanguine than I was two years ago... now we've had a pretty good run and things aren't so cheap anymore. We're getting a little bit more cautious on prospects for US equities."

On His Biggest Mistake

Chanos remembers his biggest mistake as shorting AOL, saying that "it underscores the need to monitor risk on the short side. You have to be much more aware because of the unlimited and un-ending nature of the liability on the short side. We were short AOL at $8 and covered our last share at $80. We were short it for accounting reasons."

Chanos went on to note that "you have to be very careful of not shorting concepts and being short companies."

David Einhorn's Greenlight Capital is out with their Q4 letter to investors via ValueWalk. Greenlight returned 7.9% in 2012 and 19.4% annualized.

The key takeaways from Greenlight's fourth quarter activity include:

- Bought more Apple (AAPL): They originally trimmed their position size in the third quarter, but as shares fell in Q4, they bought back some of their stake. Einhorn has held AAPL for quite some time as he originally purchased around $248 and this seems to be the only other time he's added to the position.

- Covered Pitney Bowes (PBI) Short: Greenlight labeled this company a 'melting ice cube' due to facing secular challenges of declining US mail volumes. Many hedgies have been short this name and we've also posted up how hedge funds have been shorting competitor Neopost as well.

Tuesday, January 22, 2013

Continuing his round of rare recent media appearances, Appaloosa Management's David Tepper was on Bloomberg today telling people "to be long equities" as he's bullish. Last month we highlighted his other interview where he said there's a lot of upside in equities,

Bullish on Equities

Valuation is part of the reasoning for his bullish call on equities as a whole: "If you look at the markets, they are trading at a really low multiple. 13 handle this year, 11 handle next year on the S&P."

Additionally, he simply points to the vast money creation across the globe as a reason to continue to ride the equity train.

He drew attention to an incredibly underweight equities stance by retail investors, pensions and more. He feels that eventually there will be a shift. Inflows to equity funds at the start of the year were at higher levels than they have been in quite some time.

Tepper gave a memo to long/short managers too, saying "good luck, because you can't get long enough" in this environment as he feels there will be a 'party like the 90's.' Arguing potential for 20-30% returns in equities, he feels you don't want to be long risk averse assets like Treasuries, the yen, or the swiss franc. He says to be long equites and 'equity-like' things.

His most notable soundbite was probably when he said that the US is on
the "verge of an explosion of greatness." Regarding Europe, Tepper
feels that the tail risk there is a non-issue, at least for this year.

Likes Citigroup (C)

He pointed out his fondness for shares of Citigroup (C), arguing that it
potentially has 50% upside from here, saying the company's foreign
business is very valuable.

Bullish on Airlines

Tepper highlights the reasons to like airline stocks: a potential strong dollar scenario and oil remains largely flat (due to potential new discoveries etc), you have an industry that will do will in that scenario, and you have a consolidating industry, and you have capacity down this year. He's looking for some airlines to start returning capital as well.

While everyone will focus on Tepper's bullish comments, he made a good point regarding position sizing and tracking his hedge fund's holdings. While Citigroup is one of his larger positions, he mentioned it's only a 1.5% or 2% position compared to his firm's overall AUM.

Tepper says that instead of looking at the position size of the investment relative to his firm's AUM, look at how much of a given company that they own if you're tracking their positions.

He notes that he sizes positions accordingly to how easily they can get in and out. He says that, "I value liquidity a lot." So he's a long-term investor but he likes stocks like Apple (AAPL) that are extremely liquid. He learned a very valuable lesson in 1998 regarding liquidity in Russia and that obviously shapes his decisions to this day.

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